FINAL TEST

Section 1: Choose the correct answer (20pts - 1pt/correct answer)

1. A bank that wants to monitor the check payment practices of its commercial
borrowers, so that moral hazard can be prevented, will require borrowers to

A) place a bank officer on their board of directors.

B) place a corporate officer on the banks board of directors.

C) keep compensating balances in a checking account at the bank.

D) purchase the banks CDs.

2. A common stock is a claim on a corporations

A) debt.

B) liabilities.

C) expenses.

D) earnings and assets.

3. Typically, borrowers have superior information relative to lenders about the potential
returns and risks associated with an investment project. The difference in information is
called ________, and it creates the ________ problem.

A) adverse selection; moral hazard

B) asymmetric information; risk sharing

C) asymmetric information; adverse selection

D) adverse selection; risk sharing

4. An example of the problem of ________ is when a corporation uses the funds raised
from selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its
employees and their families.

A) adverse selection

B) moral hazard

C) risk sharing

D) credit risk
5. An important function of secondary markets is to

A) make it easier to sell financial instruments to raise funds.

B) raise funds for corporations through the sale of securities.

C) make it easier for governments to raise taxes.

D) create a market for newly constructed houses.

6. Financial institutions that accept deposits and make loans are called ________
institutions.

A) investment

B) contractual savings

C) depository

D) underwriting

7. Which of the following is not a nontransaction deposit?

A) Savings accounts

B) Small-denomination time deposits

C) Negotiable order of withdrawal accounts

D) Certificate of deposit

8. Banks earn profits by selling ________ with attractive combinations of liquidity, risk,
and return, and using the proceeds to buy ________ with a different set of characteristics.

A) loans; deposits

B) securities; deposits

C) liabilities; assets

D) assets; liabilities

9. When you deposit a $50 bill in the Security Pacific National Bank,

A) its liabilities decrease by $50.

B) its assets increase by $50.

C) its reserves decrease by $50.

D) its cash items in the process of collection increase by $50.

10. Financial markets have the basic function of

A) getting people with funds to lend together with people who want to borrow funds.

B) assuring that the swings in the business cycle are less pronounced.

C) assuring that governments need never resort to printing money.

D) providing a risk-free repository of spending power.

11. The difference of rate-sensitive liabilities and rate-sensitive assets is known as the

A) duration.

B) interest-sensitivity index.

C) rate-risk index.

D) gap.

12. If bad credit risks are the ones who most actively seek loans and, therefore, receive
them from financial intermediaries, then financial intermediaries face the problem of

A) moral hazard.

B) adverse selection.

C) free-riding.

D) costly state verification.

13. Long-term debt has a maturity that is __________.

A) between one and ten years.

B) less than a year.

C) between five and ten years.

D) ten years or longer.

14. Financial intermediaries develop ________ in things such as computer technology

which allows them to lower transactions costs.

A) expertise

B) diversification
C) regulations

D) equity

15. The bond markets are important because they are

A) easily the most widely followed financial markets in the United States.

B) the markets where foreign exchange rates are determined.

C) the markets where interest rates are determined.

D) the markets where all borrowers get their funds.

16. Changes in stock prices

A) do not affect peoples wealth and their willingness to spend

B) affect firms decisions to sell stock to finance investment spending.

C) occur in regular patterns.

D) are unimportant to decision makers.

17. Financial markets promote greater economic efficiency by channeling funds from
________ to ________.

A) investors; savers

B) borrowers; savers

C) savers; borrowers

D) savers; lenders

18. A debt instrument sold by a bank to its depositors that pays annual interest of a given
amount and at maturity pays back the original purchase price is called

A) commercial paper.

B) a negotiable certificate of deposit.

C) a banker acceptance.

D) federal funds.

19. Collateral is ________ the lender receives if the borrower does not pay back the loan.

A) a liability
B) an asset

C) a present

D) an offering

20. Economies of scale enable financial institutions to

A) reduce transactions costs.

B) avoid the asymmetric information problem.

C) avoid adverse selection problems.

D) reduce moral hazard.

Section 2: Decide whether the statements are true (T) or false (F) (20pts -
2pts/correct answer)

21. When a countrys currency depreciates, its goods abroad become more F: Answer: cheaper,
expensive and foreign goods in that country become cheaper. more expensive

22. If a bank is to make a profit, it can put that to productive use through T
investing in bonds and making loans.
23. In market-based financial systems, loans from financial intermediaries F: Answer: lower
are more important for corporate finance than marketable securities, but
at a higher extent than in other financial systems.
24. Generally, increasing interest rates from the banks encourages T
individuals from lending.
25. Loans represent the most important source of finance in terms of funds T
raised externally in most cases.

26. Treasury Bonds typically have the original maturity of less than 1 year F: Answer: 10 - 30
years

27. Municipal Governments and Corporations can issue stocks. F: Answer:

Corporations

28. A bond is a debt security that promises to make payments periodically for T
a specified period of time.

29. The organization responsible for the conduct of monetary policy in the F: Answer: Federal
United States is the U.S. Treasury. Reserve System

30. Call provision is a chareacteristic of Corporate Bonds. It gives the issuer T

the right to force the holder to sell the bond back.
Section 3: Fill in the gaps (30pts - 3pts/correct answer)

time savings marketable financial maturity

institutions

liquidity checkable coupon rate mortgage commercial

banks

par value securities penalty nondepository bond

- (31)______________ accept deposits to make loans and to buy government securities.

Deposits are broad in range, including (32)______________ deposits (deposits on which
cheques can be written), (33)______________ deposits (deposits that are payable on
demand, but do not allow depositors to write cheques), (34)______________ deposits
(deposits with a fixed term to maturity). Loans include consumer, commercial and (35)-
______________ loans. (5)

- A bond has three main components: the (36)______________, or the stated interest on
the debt; the (37)______________, or the life of the bond; and the (38)______________,
the principal or the total amount initially borrowed that must be repaid to the
lender at maturity.

- The major difference between the primary and secondary markets is the (39)-
______________ the secondary market provides to investors. If a strong secondary
market exists for a financial asset, investors know that the asset can be liquidated fairly
quickly and without (40)______________, other than the fees for handling the
transaction.

Answer:

31. commercial banks 32. checkable 33. savings

34. time 35. mortgage 36. coupon rate

37. maturity 38. par value 39. liquidity

40. penalty

Section 4: Answer the questions (30pts - 10pts/correct answer)

41. Compare Common stock and preferred stock.

Answer: Common stocks represent ownership interests in the firm. Common

stockholders receive dividends (when distributed), take capital gains (or losses) when the
stock price on the market increases (or decreases), and have the right to vote.
Preferred stocks are equity claims with limited ownership rights in comparison to
common stocks. They differ from common stocks in several ways. First, preferred stocks
distribute a fixed constant dividend, which makes them more similar to bonds than to
common stocks. Second, the price of preferred stocks is relatively stable, as the dividend
is a constant amount. Third, preferred stocks do not usually carry voting rights. Finally,
preferred stockholders have a residual claim on assets and income left over after creditors
have been satisfied, but they have priority over common stockholders.

42. In some cities, newspapers publish a weekly list of restaurants that have been cited
for health code violations by local health inspectors. What information problem is this
feature designed to solve? How?

Answer: This solves both adverse selection and moral hazard. People who dine out at
restaurants may have a difficult time identifying restaurants that dont meet certain health
standards. Because of this, some people may not want to eat out at all. Also, restaurants
dont have an incentive to follow health regulations since diners cant distinguish
restaurants that meet the health standards from those that dont. However, publishing the
names of restaurants cited for health code violations allows people to identify unsanitary
restaurants and thus holds restaurants accountable for following health regulations.

43. Discuss the features that differentiate organized exchanges from the over-the-
counter market.
Answer: Organized exchanges have a physical building where business is conducted. They
generally have a governing board that establishes rules for trading. The organized exchanges tend
to have larger firms listed on them than trade over the counter.